RBI Crackdown on Evergreening: Tightening the Noose on Bad Loan Concealment

Detailed Narrative:

The financial landscape in India has witnessed a significant development as the Reserve Bank of India (RBI) takes a firm stance against the practice of “evergreening” by banks and non-banking financial companies (NBFCs). Evergreening, a term that has raised eyebrows in the industry, refers to the concealment of non-performing or bad loans by allowing delinquent borrowers to take on additional loans to repay their existing ones.

Alternative Investment Funds (AIFs), privately managed funds with a minimum investment of INR 1 crore, have been at the center of this controversy. These funds, which allocate investments across various asset classes such as venture capital, infrastructure, and high-yielding debt instruments, have been growing rapidly in India, alongside mutual funds.

The RBI’s concerns stem from the suspicion that certain banks and NBFCs may be utilizing AIFs as a means to conceal their non-performing assets (NPAs) or bad loans. The regulator has identified instances where investors in AIFs have leveraged their investments to transfer their bad loans to these funds, effectively removing such loans from their books.

To illustrate this practice, consider a scenario where an NBFC has extended a loan of INR 50 crores to a real estate developer facing financial distress and on the verge of default. In an attempt to address the potential provisioning and NPA issues, the NBFC invests INR 50 crores in an AIF. Subsequently, the real estate developer issues bonds worth INR 50 crores, which are subscribed by the AIF. The funds raised through these bonds are then used by the developer to settle the outstanding loan with the NBFC, effectively averting the provisions and NPA problems that the NBFC would have faced.

In response to such practices, the RBI has implemented stringent measures through its new guidelines. Regulated entities are now prohibited from investing in any scheme of an AIF that holds downstream investments, either directly or indirectly, in a debtor company of the regulated entity. This implies that if a bank or NBFC has financial exposure to or has extended loans to a particular company within the preceding 12 months, they are restricted from investing in an AIF scheme that channels funds into the same company.

Furthermore, the RBI has instructed lenders who have invested in AIF schemes falling within the scope of the aforementioned circular to liquidate their investments within a 30-day timeframe. Failure to do so will result in the lender being required to make a full provision, accounting for 100% of the value of such investments.

The comprehensive nature of the directives, which apply retrospectively to all types of AIFs, has sparked polarized opinions among experts. While some appreciate the initiative for enhancing transparency in the disclosure of bad loans, others argue that the RBI has taken a sledgehammer approach to resolve the problem.

The directive’s requirement for lenders to liquidate their AIF investments within a 30-day timeframe poses a significant challenge, compounded by the absence of a secondary market in India for these unlisted AIF units. Lenders may find themselves compelled to engage in a fire sale, potentially resulting in losses on their portfolios.

The potential repercussions of the RBI guidelines are substantial, with an estimated impact on Assets under Management (AUM) ranging from INR 20,000 to INR 30,000 crores. Banks will be required to consider a fire sale to offload assets or provision for them, affecting their capital adequacy. NBFCs and AIFs with high exposure to real estate builder loans are expected to face the maximum impact of the RBI guidelines.

The newly introduced guidelines will discourage lenders from investing in AIFs, even when driven by genuine motives. Should lenders choose to proceed with such investments, they will require a commitment from the AIFs ensuring they refrain from investing in any debtor company associated with the lender, creating a significant barrier to lenders investing in AIFs.

Various industry bodies have actively communicated their concerns to the RBI, asserting that the guidelines may impede the inflow of authentic investments into AIFs. They have proposed an alternative approach, suggesting that the directives be enforced only when the lender’s investment in the AIF constitutes at least 25% of the AIF’s total investment in the debtor company, and the lender’s loan to the said debtor company is due within a year of the lender’s investment in the AIF. This would ensure that genuine investments in AIFs would continue while discouraging evergreening.

FAQs:

Q1. What is the purpose of the RBI’s new guidelines?

A1. The RBI’s new guidelines aim to curb the practice of “evergreening” by banks and NBFCs, where delinquent borrowers are allowed to take additional loans to repay existing ones, effectively concealing the true extent of bad loans.

Q2. How do the guidelines address the issue of evergreening?

A2. The guidelines prohibit regulated entities from investing in Alternative Investment Funds (AIFs) that hold investments, directly or indirectly, in companies to which the regulated entity has extended loans within the preceding 12 months.

Q3. What is the significance of the 30-day timeframe for liquidating AIF investments?

A3. The RBI has instructed lenders who have invested in AIF schemes falling within the scope of the guidelines to liquidate their investments within a 30-day timeframe. Failure to do so will result in the lender being required to make a full provision, accounting for 100% of the value of such investments.

Q4. What are the potential implications of the RBI guidelines?

A4. The guidelines are expected to have a substantial impact on Assets under Management (AUM) ranging from INR 20,000 to INR 30,000 crores. Banks may be compelled to engage in a fire sale to offload assets or provision for them, affecting their capital adequacy. NBFCs and AIFs with high exposure to real estate builder loans are expected to face the maximum impact.

Q5. What alternative approach have industry bodies proposed?

A5. Industry bodies have proposed that the directives be enforced only when the lender’s investment in the AIF constitutes at least 25% of the AIF’s total investment in the debtor company, and the lender’s loan to the said debtor company is due within a year of the lender’s investment in the AIF. This would ensure that genuine investments in AIFs would continue while discouraging evergreening.